Options under the Russian law

Having seen enough of the American series like "Silicon Valley", many got an idea to start option programs for the team. An option contract implies the right to an employee to receive a share or interest in a company if certain conditions are met.

Why give an option?

An option agreement has a lot of advantages. For example, you will not have to pay much here and now, if you promise a share in the future. And even if the employee fulfills the set KPIs on time, it will cost you only notary fees.

Ideally, an employee remains interested and efficient even after the issuance of an option, since the more expensive the company, the higher the share selling price in the future. Therefore, he works with all his might, trying to increase the company capitalization. Unfortunately, in reality, the employee does not always continue to work well, and it is important to keep in mind that dismissing an employee with an option is though task.

Risks

The vote of the owner of a share matters, especially when voting on the most important decisions. This is important to remember when planning an option program. Therefore, if you do not want to depend on your employee in key decisions such as raising funds, the company's documents must state that individual participants (employees with options) do not receive the right to participate in general meetings and waive the right to dividends.

There is one more nuance, in practice an option has a very conditional commercial value, since it represents a small non-blocking share. This moment is especially significant in non-public joint-stock companies. In order for an employee to realize his share in the next round of investments (to cash out), they need to have the right to join the transaction (tag along) specified in the agreement.

However, competent legal clearance removes most of the shortcomings of the option.

Option offer

Founders need to pre-allocate an option pool, that is, the share that will be distributed among the recipients of options. Under Russian law, companies (both LLC and public companies) cannot keep their shares or stakes on the balance for a long time. Since a joint stock company is limited to a 10% share and a year term, it is still more difficult for an LLC because by default the company cannot buy back its shares or have any unpaid assets. This means that when the option is due, the company may simply not have free shares.

There is a way out, for example, to enter into an option agreement not with the company, but with the owner of a large package. This package will actually become an option pool. Such an agreement under article 429.2 of the Civil Code is called the “option to enter into an agreement” or “option offer” and is subject to notarization. When a stipulated condition occurs, it will be enough for the employee to come to the notary, and the share will be transferred automatically (offer acceptance).

The option offer also often includes confidentiality and non-compete clauses that apply even after the dismissal (non-compete agreement).

Phantom option

Sometimes even the notarization of the option offer does not secure all the risks. For example, an option pool holder may sell it before issuing an option to an employee, or unfairly transfer it to an affiliate. Foreign companies faced this even in the 2000s, when they entered the Russian market. The problem was solved with the help of the so-called "phantom options". In fact, this is a regular premium, the amount of which is calculated on the value of the company. As a result, the employee receives a payment equal to the amount from the sale of the real share. But in fact, the share is not transferred to anyone.

This option has advantages:

simplified workflow compared to conventional options,

automatic cancellation upon dismissal of an employee,

exclude employee claims for management and dividends.

There are also disadvantages:

The company will lose 33% of the amount on taxes and contributions from the phantom option, while if the share were sold, the tax would be only 13%, and it would be paid by the employee.

If a phantom option is issued by a non-public company, you need to describe in detail what indicators will be used to calculate the premium amount. In case of a real option, the employee and the market assume this function.

Conclusions

Many believe that the option will save on payments to the team without offering anything serious in return. Unfortunately, not all business tricks from "Silicon Valley" can be immediately put into practice. A translation of an English option contract will not work under Russian law. However, if the employer is familiar with the Civil Code design (such as an “option to conclude a contract”), the employee will eventually be able to obtain and even realize his option.